For the past couple of years, apartment vacancies have been on the rise in downtown Minneapolis, where construction has been most robust, while vacancy rates have fallen in many suburbs. That changed this fall, likely temporarily.

The suburbs, especially those along the west edge of the Twin Cities metro area, have seen a surge in construction, fueling year-over-year increases in the vacancy rate during the third quarter while construction in the urban core so far this year has declined.

Across all suburbs, the vacancy rate (not including buildings still being leased) increased from 3.4% to 4%, while downtown Minneapolis and St. Paul saw vacancies decline more significantly compared with last year, according to a quarter report from Marquette Advisors.

"That changes here shortly," said Brent Wittenberg, vice president of Marquette Advisors.

He said with thousands of apartments under construction across the metro, the vacancy rate is expected to increase in much of the region next year.

Across the metro, the apartment vacancy rate increased to 4.2% by the end of September, according to the report, which doesn't include income-restricted and senior housing. That was up slightly from the previous quarter and last year at the same time.

Including new buildings that are still filling their leases, the vacancy rate stood at 5.6%. The market is considered evenly balanced between supply and demand when there's a 5% vacancy rate.

Despite the increase in apartment vacancies, rents posted a solid gain. The average rent price across the metro was $1,460, up 4.5% through the past year. Edina and downtown Minneapolis were the most expensive, with monthly rents that exceeded $2,000, increasing 6% in Edina and 3.9% in downtown Minneapolis. In downtown St. Paul, the average rent was $1,649, on par with last year.

The wild card for apartment demand in the coming months will be mortgage interest rates. While employment growth, in‐migration and household formation typically drive demand for rentals, higher mortgage rates have made homeownership more expensive than it was a year or two ago. For an untold number of would-be homebuyers, renting might make more sense. That's especially true when house prices are on the rise, which has been the case in the Twin Cities.

Wittenberg said for rental owners, the southwest suburbs — including St. Louis Park, Edina and Minnetonka — are experiencing the most turbulence as the area adjusts to a surge in apartment construction.

During the first nine months of the year, more than 2,500 units have completed, and another 3,800 should finish by the end of next year. The vacancy rate for established buildings in that area increased to 5.1% but is now 9.4%, including all new units in lease-up.

In downtown Minneapolis and St. Paul, where the vacancy rate has been among the highest in the metro for the past few years, vacancies have declined slightly. That decline is likely a blip, Wittenberg said.

"We've seen a slowdown in new unit deliveries thus far," he said. "Looking ahead, we expect another spike in downtown vacancy into 2024."

Chris Sherman, president of Minneapolis-based Sherman Associates, said the recent decline in the vacancy rate down is consistent with what the company is seeing at its downtown-area apartment buildings. The reopening of so many restaurants and the return of sporting events and concerts, he said, has positively influenced demand for apartments.

"That's driving more and more people to live downtown," he said. "Demand has picked up significantly."

With the downtown population now growing again, leasing has been especially strong for apartments that rent for $2,000 to $3,000 per month, but he said there's also been a recent uptick in leasing for more expensive apartments. In just the past week, the company rented two penthouse apartments at the Encore, which is across from Gold Medal Park in the Mill District.

The company is converting a former office building into apartments and is building a high-rise along Washington Avenue that will be finished next year. After the next batch of apartments that are already slated to come to market, he said there isn't much in the pipeline because many developers are having trouble getting financing.

So far this year, only 230 new units have come to market in downtown Minneapolis, Wittenberg said. But with more than 2,000 new units expected to open downtown in the next 18 months — including the Sherman projects — it's likely to become an even stronger renter's market. And not just downtown.

"We're anticipating a surge in new suburban supply, particularly in the southwest 'burbs," he said. "More renters are now looking to the suburbs, as there are more new construction options available there."